Challenges and opportunities of policymaking for insurers’ asset allocations 5 April 2017, Dublin Cristina Mihai
Contents 1 Who we are 2 Insurers as largest institutional investors 3 Regulation: focus on Solvency II 4 The EU Investment Plan 5 Wrap-up 2
Contents 1 Who we are 2 Insurers as largest institutional investors 3 Regulation: focus on Solvency II 4 The EU Investment Plan 5 Wrap-up 3
Insurance Europe Insurance Europe represents around 95% of European insurance market by premium income European insurance market: largest market in the world (35% share in 2013) €9.9trn investments €1.2trn in premiums €0.9trn in claims 34 members (national associations) 27 EU member states 5 non-EU markets ( Switzerland, Iceland, Norway, Turkey, Liechtenstein) 2 associate members ( Serbia, San Marino) 1 partner ( Russia) 4
Contents 1 Who we are 2 Insurers as largest institutional investors 3 Regulation: focus on Solvency II 4 The EU Investment Plan 5 Wrap-up 5
Investing is a consequence of our business model 6
. . . and creates significant benefits Benefits for policyholders Benefits for economic growth Benefits for financial stability 7
Largest European institutional investors 8
Contents 1 Who we are 2 Insurers as largest institutional investors 3 Regulation: focus on Solvency II 4 The EU Investment Plan 5 Wrap-up 9
Many policy developments impact insurers 10
Solvency II: huge change and improvement Solvency I Solvency II ▪ Cost accounting valuation, limited rules on ▪ Market valuation and best-estimates liabilities. assumptions for liabilities. ▪ Very simple factor-based approach for ▪ Risks measured by sophisticated internal measuring risks. models or standard approach, 28 risk types. ▪ Solo-based regime. ▪ Solo and group based regime. ▪ Relatively low minimum solvency ▪ Minimum capital requirements (MCR) & much requirements. higher Solvency Capital Requirements (SCR). ▪ Little governance and risk-management ▪ Extensive governance and RM. requirements. ▪ Limited reporting requirements. ▪ High requirements, >150 reporting templates. ▪ Limited powers to intervene before failure. ▪ Ladder of intervention: before material risk of failure. ▪ 199 pages covering 13 directives. ▪ >3000 pages. 11
The long- term issue: understanding insurers’ concerns Long-term and predictable liabilities allow insurers to: Hold assets long-term (or to maturity for bonds) and have control over when/if to sell Avoid losses due to forced sales Therefore insurers can reduce or eliminate exposure to temporary declines in asset prices Unfortunately Solvency II generally assumes insurers act as traders and are exposed to the same volatility of market prices This is not at all the reality and it matters because it has a huge impact on how Solvency II measures market risks for insurers 12
The wrong measurement can artificially exaggerate overall capital in two ways… Indirect • A trading view ignores link between assets & liabilities Solvency ratio • This creates artificial volatility and need for additional capital = buffers Available Capital Required Capital Direct A trading view exaggerates the • true market risks by requiring capital for the full market volatility 13
With no LTG measures volatility would be completely unmanageable 3 simplified insurance companies – with fully cashflow matched “AA” assets backing 5, 10 & 15 year liabilities 14
The volatility adjustment addresses the problem only partially In the case of 15 years duration the volatility adjustment (VA) helps to dampen the effect of spikes in spreads but there is still significant volatility that remains in the balance sheet. EUR Corporate AA 400% 300% 200% 15 year duration 100% 15 year duration with VA 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 -100% -200% -300% 15
How should Credit Risk for bonds be measured for insurers? ▪ Trading view: Based on Credit Spreads “Extreme” price change AA bonds 2007 – 2008 = 30% Long-term view: Based on credit default losses ▪ “Extreme” losses on AA bonds 2007 – 2008 = 0.2% * * Assumes a 50% recovery rate. Actual defaults were 0.4%. 16
Example: measuring risk for securitisations Capital for 5-year AA STS securitisation compared to actual losses during crisis Actual default during entire Risk for Long- 0.14% term Investor crisis period Original Calibration (QIS5, Trading approach: 80% Economically 2009) wrong and a barrier to investment even EIOPA proposal for High with improvements Quality securitisations (end- 42.50% made by 2013) Commission Actual calibration chosen for 15% Solvency II 17
Contents 1 Who we are 2 Insurers as largest institutional investors 3 Regulation: focus on Solvency II 4 Investment Plan for Europe 5 Wrap-up 18
Investment Plan for Europe Launched in end-2014 - 3 key areas of interest for insurers: 1. Increase supply of infrastructure assets for private investors 2. Provide public support where needed 3. Address regulatory barriers – Capital Markets Union 19
Some progress, but more ambition needed ▪ Supply of infrastructure ▪ Remains limited across EU member states ▪ Lags behind insurers’ willingness and ability to invest ▪ Public support ▪ Worrying examples of crowding-out ▪ Regulation (Solvency II) ▪ Limited changes, more is needed AA infrastructure bond Original Calibration (Oct. 2014) 15.5% Initial EIOPA proposal (July 2015) 13.5% Final calibration (Sept. 2015) 9.3% Calibration based on actual credit performance 5.9% 20
Policymakers need to address the right questions Is there a difference between measuring exposure to long-term default risks and exposure to short-term trading risks? Does the ability of insurers to avoid forced sales change their actual risk exposure? Is the current Solvency II assumption that insurers would be forced to sell their entire portfolio at a huge loss in a time of stress reasonable and backed by evidence? 21
Contents 1 Who we are 2 Insurers as largest institutional investors 3 Regulation: focus on Solvency II 4 The EU Investment Plan 5 Wrap-up 22
Getting the regulatory balance right is challenging, but vital Design and application of insurance regulation should focus on: Identifying and achieving right outcomes Avoiding unintended consequences Considering the impact on the economy 23
Good regulation is vital, but bad regulation can be as damaging as too little regulation
Bad regulation can be worse than too little (1) Titanic sank in 1912. The ship was in compliance with regulation at the time. Over 1500 died. Key cause for deaths: not enough lifeboats 25
Bad regulation can be worse than too little (2) ▪ Led to "lifeboats for all" movement and new regulation came into force in March 1915. ▪ During the development of the regulation, the shipping industry had warned that some vessels would turn 'turtle' if you attempted to navigate them with this additional weight – concerns were not heeded. ▪ Many ships had to be retrofitted with more lifeboats to comply, including SS Eastland, a US passenger ship used on the Great Lakes. 26
Bad regulation can be worse than too little (3) Eastland sank in 1915, a few meters from the dock. Nearly 850 died. Key cause for deaths: too many lifeboats, making ship top heavy and prone to capsizing. For the SS Eastland, even though stability was already known concern - no tests were conducted to determine how the additional weight affected the boat's stability. 27
For more information www.insuranceeurope.eu Twitter: @InsuranceEurope
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